Investing For Income In Your Accumulation Years

When I sold my dividend stocks in 2015 my portfolio was worth $100,000 and generated about $4,000 a year in dividend income. I’ll admit it was motivating to watch the dividends grow each year as I added new money to my portfolio and companies increased their payouts. I regularly tracked my progress and projected out scenarios where I could retire and live off the dividends.

Indeed, following some of the popular dividend investing blogs was equally inspiring, as their income-generating portfolios already approached the tens of thousands annually.

But one thing I learned about myself as I sorted through my own behavioural biases was that as a thirty-something investor I was fixated on investing for income rather than total returns. I was decades away from retirement, so why did it matter how much income my portfolio generated right now? Instead, I should focus on saving and growing the entire nest egg.

Investing for Income

One excellent blog I’ve followed for years is My Own Advisor, written by Mark Seed from Ottawa. Mark chronicles his journey towards financial independence and retirement through his unique investing style – a hybrid of dividend stocks and index ETFs.

Mark regularly updates his dividend income and posts thoughtful commentary on the choices he makes inside his portfolio. One recent update got my attention when Mark wrote about some changes to his TFSA; selling off a Canadian ETF to focus instead on more dividend stocks.

On the changes, he said:

“I’m striving for more dividend income from my portfolio; not relying on capital gains in our Canadian stock portfolio as we approach semi-retirement.”

Mark has set-up a cash-generating portfolio that currently churns out more than half of what he needs to live off of in semi-retirement. It’s encouraging to watch the compounding effects of those dividends as they snowball into bigger and bigger numbers each year.

But here’s the thing. Mark doesn’t need those dividends today. He needs them in retirement, which might be 10 or 15 years away. Why not adopt a total return approach during your accumulation years and then switch to an income approach when you need the money in retirement?

Imagine for a moment there are two investors, Income Ernie and Total Return Tim. Both Ernie and Tim are 30 years old and have saved $100,000 in their retirement accounts. They each hope to generate annual income of $30,000 by age 55.

Income Ernie invests in dividend stocks, focusing on blue-chip companies that have a track record of growing their dividends over time. Total Return Tim buys a couple of broad market index ETFs, opting for maximum diversification and a relatively hands-off approach.

Both Ernie and Tim save $10,000 per year for the next 25 years and earn a comparable 6 percent annual return. Each of their portfolios is worth $1 million, with Ernie’s spinning off $30,000 per year in dividend income, while Tim’s portfolio of ETFs yields just 1.8 percent, or $18,000 per year. Tim is $12,000 short of his income goal.

But after meeting with his good friend Ernie, Tim sells his ETFs and buys the exact same stocks that Ernie holds in his portfolio. Problem solved. Tim’s portfolio now generates $30,000 per year in dividends, the same as Ernie’s.

Final thoughts

The allure of investing for income can make it seem like the annual compounding of dividends has some sort of super-snowballing effect. As companies increase their dividends, the current yield rises in relation to the initial price you paid for the stock, making it seem like you’re earning even more money.

But it doesn’t matter whether you bought 1,000 shares of TD stock for $6 in 1995 or bought 1,000 shares of it yesterday for $63. The dividend today – 60 cents per share – is what matters, and in either case would pay you $600 every three months.

There’s nothing wrong with building up a cash-generating portfolio in your accumulation years. If you’re the type of investor who is motivated by the dividend needle moving up every year, I say go for it.

Just know that even if you choose to take a more hands-off approach to investing in your accumulation years, like I do with my four-minute portfolio, you can still flip the switch to a more active, income-oriented approach in retirement without missing a beat.

Thanks for mentioned my post Robb. Glad it got you thinking and reflecting.

As you may appreciate we’re certainly motivated by the rising dividend income over time. That said, you are correct with your scenario of course.

I know why I continue on the course I have – largely to take benefit from the dividend tax credit for my growing non-registered portfolio. I have historically owned a number of REITs inside my TFSA, along with Canadian utilities and telco stocks, so to balance out those assets I own other stocks in the taxable account. My Canadian portfolio is now similar to the top-20 holdings of ETFs XEI and XIU. My returns from my Canadian portfolio are therefore largely the same as XIU over the last 7-years – so I’m not under performing.

So, why not just buy the index or ETF? Why hold the same stocks as the big funds own? I control the asset weights and I pay no on-going fee for doing so. I also feel dividends are more stable than the hope of capital gains; although dividends are not guaranteed.

I don’t need those dividends today, correct, but in 10 years I probably will.

As for other investors I would and do encourage them to consider a total return approach via indexing if they are at all unsure about investing in individual stocks. That approach provides the best chance of market-like returns for much less hassle.

All told, like you, I too will be interested to see if my approach works exactly the way I think it might. In 10 years I hope to find out (for semi-retirement).

Keep up the great work on this site.

…Always great to read how other bloggers approach things and share different perspectives.

Dividend investing is ridiculously stupid. The only benefit is for Canadian dividends in a non-registered portfolio for low income earners – this has preferential tax treatment, otherwise there are no real advantages.

Dividends aren’t magical. When a company pays out a dividend, their stock price drops by that value. If it’s a foreign company you get hit with taxes (the same as your marginal rate) and you can also get hit with a foreign withholding tax (this doesn’t happen if there are no dividends).

If you just sell some of that investment, you’ve created your own dividend and it gets taxed based on capital gains – half your marginal rate. You never NEED dividends in retirement. It might be easier to have it automatically pay out instead of doing it yourself, but the taxes are not worth it.

You also sacrifice diversification and it requires more time and maintenance. Simple index funds are definitely preferable.

In 2009, my dividends still get paid in full, while twice as much shares should have been sold to get the same amount. And, since I didn’t have to sell anything,
my portfolio value later recovered with the market.

Canadian dividends in your TSFA and RRSP are not taxed. U.S dividends in your RRSP are not taxed either, due to a tax treaty between our two countries.

Buying quality stocks and holding them for 30-50 years doesn’t require much time nor maintenance. And there is no transaction fees when holding, while ETFs management fees are charged every year.

Having all my expenses covered by dividends and never having to worry about fluctuations of the stock market is great for the peace of mind. You should try it!

If you are living off investment income, have a relatively low income (common for retirees) and have investments in non-registered accounts, then Canadian dividends are a good strategy. This post is “Investing for Income in your Accumulation Years”. It’s’ better to leave the money untaxed and pay capital gains later if you are accumulating money. Once retired, that could change from a tax perspective. Although, I think buying an ETF like XEI would be preferable to individual stocks.

As far as “not worrying”, I care about how much money I own – not how much money my investments are paying me.

Buying and holding individual stocks leads to a low level of diversification and an unbalanced portfolio. This creates extra volatility which can be removed with proper diversification. If you know how to select index funds well, you could be paying less than 0.2% in fees – at that point the fees do not really affect your performance.

Unless you are in the top 10% income bracket (or more), almost all of your investments during the accumulation phase will be in your TFSA and RRSP accounts, therefore tax free.
Also, quality dividend stocks tend to appreciate at least as fast as their reference index. So, you get the best of both worlds: superior capital gains + dividends!

I had a look at the XEI ETF and I own each and everyone of its top 10 stocks (which amount to 50% of that ETF). With a yield of 4.05% after MER, it is a good choice for someone starting (capital < 20K$). Since I hold these stocks individually, my yield is not diluted by capital injections from others and is now above 8%.

As long as my income is higher than my expenses and grows faster than inflation (which is the case with dividends), I don't care much about the total value of my portfolio.
The stock market could stall for a long period of time, like it did from 1965 to 1982, and that would not affect me too much, since I don't need to sell any stocks for income.

Regarding diversification, nothing prevents anybody to buy stocks from 50, 100 or 500 different companies. Sectorial diversification is more important though.

I don’t think it’s a good idea to switch to a dividend focused strategy at retirement just to create cash flow. Focusing on dividends creates an illusion of safety, but you just end up with a less diversified portfolio, which is therefore less efficient. You’ll have a wider dispersion of returns, which on average will not do as well as a total return approach. That’s what the research shows, anyway. I understand that people like to focus on dividends for various behavioural reasons – and that’s fine – but it’s good to know which approach will likely give you the optimal outcome.

What you need in retirement is cash flow, not income. An easy way to do that is described here.

I’ll never understand employed people who want to “take advantage of the dividend tax credit”. To start with, the growth in TFSAs and RRSPs is tax-free, so focusing on the DTC only makes sense if you’ve completely filled both your TFSA and RRSP. Zero taxes is better than low taxes. Even if TFSA and RRSP room is fully used, it doesn’t take much income before the DTC is less valuable than the 50% capital gains inclusion rate.

I do dividend investing with a total return approach and beat the index. Dividend investing and total return can be used to work together. That’s usually done through Dividend Growth approach and not from the companies that increase their dividends by 1 cent annually.

Mind you, nearly 50% of my money is in US investments and not in Canada with the limited investing options we have here. I compare my approach to the Canadian and US index and beat both of them.

My goal is still to earn enough from the dividend to not worry about the capital and the 4% (inadequate) withdrawal rule.

But what “index” are you using to benchmark your performance? Dividend investing is are essentially large cap value stocks, so the appropriate risk adjusted bench mark is a large cap value index. Value stocks are expected to outperform the broad market over the long term, so comparing a dividend focused strategy to the broad market index is an apples to oranges comparison.

@Grant
You are correct. I usually look at a few indexes since it’s easy to compare with how I am setup.

Your point goes to show that even index investing is apple to oranges depending on what index you take and how much you put in each index. If you follow the rule of thumb, from decades ago, that you should have an equivalent in bond based on your age, in this low-interest environment, you are behind and your money is not keeping up with inflation.

The whole package needs to be working for someone. To be fair, if someone asks me, I usually tell them to index with ETF as most don’t have the skills, patience or interest in investing. I don’t push dividend investing as it requires some level of understanding of stocks, businesses, and financial statements.

I wouldn’t agree that “indexing is apples to oranges”. My point is that if you are stock picking you need to compare your efforts to the appropriate risk adjusted index. Asset allocation is a different issue all together, and depends on various elements such as expected returns, and one’s ability, capacity and need to take risk.

I agree with your advice to index, as due to overconfidence, many people believe they can beat the market, but in fact the vast majority do not, even if they think they are as they are not benchmarking their efforts properly.

Another note on this comment: “you can still flip the switch to a more active, income-oriented approach in retirement without missing a beat.”

Only a savvy investor can do that. Those that don’t know the difference between an RRSP and a TFSA account, could not do that. Let alone understand the difference between a REIT, an income trust, a preferred share or a common stock and all the taxes that pertains to each holding.

I don’t think it’s that easy to re-educate one’s mind on investing when you are about to approach retirement. It took me a while to figure out my dividend investing model focused on growth and total return.

Just be careful with the switch to a dividend portfolio when you get close to retirement if the assets are not in an Rrsp or tfsa. If they are in a regular account the switch will be a taxable event and taxes will be paid on the realized capital gain.

Correct. It was a little agressive for me to call it “rediculously stupid”. Should have been more tempered in my response. However, people still push a dividend strategy when there are so many disadvantages: higher taxes (income tax and foreign withholding tax), lower diversification, more trading costs, more maintenance. People also generally don’t realize there is no tax credit for us stocks. As far as beating the index, past performance is not indicative of future growth. I haven’t seen any evidence that dividend stocks have a high probability of beating the index over the long term.
People should focus on how much money they make from their portfolios, not how much money the stocks like to pay out as cash.
So many people give advice to go after dividends, but it’s not the best strategy.

Personally I like ETFs for their simplicity and low cost diversification. I don’t have the time to research individual stocks so dividend investing would be too much for me. That being said I completely understand the appeal. It can be very motivating to see those dividends roll in. It makes investing feel more ‘real’.